Why GDP and welfare are parting company

Richard Yetsenga

ANZ chief economist

By late 2015 Australia had cycled through four Prime Ministers in two-and-a-half years. Paramedics stopped asking patients the name of the PM – a previously common way of quickly assessing their state of mind.

With so much change in Canberra the wrong answer wasn’t a useful an indicator of consciousness anymore. Australia is of course not alone in this - and it has some economic bearing.

Consider the business environment; especially the low rate of wage growth and the low rate of growth in traditional business investment.

Many countries are ahead of Australia in the cycle because Australia had a second wind until 2012 due to a bounce in commodity prices. But even in those economies which are ahead, wages and business investment are weak.

The dominant approach to this from many policymakers has been to take the view there is just some oddity in the current cycle and we simply need to be patient and wages particularly will come good.

That is still possible. In fact the current recovery in the Australian economy suggests we will see some recovery in wages over the next year or two.

"If income growth doesn’t recover, we will need to tilt the policy focus or the level of community disquiet will continue to grow.” - Richard Yetsenga

But the reality is we have a puzzle in wages which has existed for five or more years. And many have given up expecting a strong business investment cycle, even in the US.

Enduring

We need to give more respect to the likelihood something more enduring is going on. I think that ‘something’ is technology.

Consider the number of sectors which are now facing competition from technology-based new entrants into their sector:

• Car companies and electric vehicles;

• Traditional media and online;

• Taxis and Uber;

• Restaurants and Uber dine;

• Accommodation and Airbnb or other online providers;

• Financial services and fintechs; and

• Of course bricks and mortar retail and either online retail or different business models for bricks and mortar, like Aldi.

I struggle to think of a sector not facing this sort of competition in some way.

These new entrants share an important feature: they can add capacity very cost effectively - either because it exists already or because they are adding digital capacity which is cheap.

On the first, think about using cars and holiday houses more often, or existing retail space being transformed into something else.

Consider universities which can’t fill their large lecture theatres after week three because everyone watches online and who now need to find a way to use the space for some commercial return.

On the second, Microsoft’s cloud business, for instance, earned $US15 billion in revenue in the last year, growing at 43 per cent a year. Can you imagine an analogue business of that size growing at that speed? Mobilising the resources required would likely prove impossible.

Capacity

What all this means is revenue is being generated but it's not taking the same scale of physical capital investment we are used to.

As well as adding capacity cheaply, the new entrants force incumbents to narrow margins to try and retain customers. And so their influence is directly deflationary.

Technology businesses by their nature often break one of the foundational laws of economics: they show increasing returns to scale rather than diminishing returns. They generate network effects.

Industries where technology becomes more dominant tend to be industries where you get a natural rise in industry concentration. This means the returns to capital tend to go up - and the returns to labour tend to go down.

For Australia you might argue there are special factors in operation, that it’s not technology. In fact Treasury just recently argued three other factors were significant:

• Spare capacity in the labour market;

• Low inflationary expectations; and

• The end of the mining boom which brought wages growth “back to earth”.

In Treasury’s view, therefore, the factors behind low wage growth in Australia are almost entirely local, and are almost entirely cyclical. If they are, then low wage growth will resolve itself in time.

This has also been the initial response from every policy institution globally I can think of. However, a number are starting to think more broadly given wage growth is still undershooting their traditional metrics after so long.

Caution

In my view there are actually three good reasons why we should be cautious about the local and cyclical interpretation:

• Wage growth has been surprisingly low for a long time. None of the factors listed by Treasury are of themselves, surprising.

• The occurrence of surprisingly low wage growth across a number of countries at the same time suggests to me our presumption should be there are some common factors at play – and we should work to find them - rather than presuming it is local factors.

• And, if technology is the global driver, then the implications are very significant. From an expected value perspective it is prudent to canvass this issue more seriously.

In fact, if it is technology, there are profound implications:

• Cycles in wages and inflation and capital heavy investment will be more muted.

• The focus on monetary policy will be more on macro prudential policy and managing the leverage cycle, than on interest rates and the inflation cycle.

• Competition (anti-trust) policy will become an increasing government focus, as industry concentration rises.

• The cycle won't bail us out of the structural issues many countries face, including major housing affordability issues (eg Australia or Hong Kong), unsustainable fiscal positions (the US; where there has been no improvement in public debt to GDP at all despite leading the global recovery) or a legacy of bad debts in the banking system (such as India and Indonesia).

• We are going to have to generate growth the hard way, through genuine reform. (If you want the reform list, The Productivity Commissionin 2012 gave us one. It is still relevant.)

There is no doubt reform is complicated and vexing, particularly in the current political environment.

This is why it is more important than ever the policies put forward take account of the circumstances we are in.

There seems to be some confusion about this issue. GDP growth is, after all, reasonable at between 2 and 3 per cent. On many forecasts (although not ours at ANZ) it will head above 3 per cent in the next year or two.

But growth in GDP and gains in welfare are not the same, even though they are related. At low rates of sustained economic growth, the difference between GDP and welfare gains become starker.

Moreover, the difference between growth in GDP and growth in GDP per person also becomes more important. In Australia, once you take account of the narrowly based gains from LNG exports, we expect growth in GDP per capita will struggle to get much above 1 per cent.

Around any average will be a range of outcomes — some do better than average and some worse.

But as the average comes down, unless you can do something about the dispersion, more of those doing worse than average will be going backwards in absolute terms. For more people it means their personal GDP growth is negative. They will be worse off.

Additionally, as gains in income — or personal GDP — are closer to zero, we should expect differences in the level of wealth, already pronounced, to increasingly become a source of concern.

Fashion

To my mind, therefore, it's not about selling the same reforms in a different fashion. The reforms themselves need to adjust:

• Economic policy needs to be more inclusive of the distributional issues, not only focussed on aggregate GDP growth outcomes.

• We need to be more transparent in recognising GDP growth driven by population change will not help this underlying disquiet because it doesn’t imply gains in income at the individual level (even if it does result in gains for those who run businesses which depend on volume).

• We need to get serious about Australia’s structural policy challenges rather than tinkering and waiting for the cycle to bail us out.

Kate Raworth has written a very challenging book titled “Doughnut Economics”; read it and you will understand the title.

In there she writes “today we have economies that need to grow, whether or not they make us thrive; what we need are economies that make us thrive, whether or not they grow.”

Now I’m not sure we need to go that far, but at the end of the day if income growth doesn’t recover, we do need to tilt the policy focus or the level of disquiet will continue to grow.

There is also a political challenge, the tension between ‘popular’ policies which may win votes in the short term but which won’t address this growing disparity and genuine reforms which may be ‘courageous’ for governments.

Let’s hope paramedics will again be able to judge lucidity by asking about the state of politics.

Richard Yetsenga is Chief Economist at ANZ

The views and opinions expressed in this communication are those of the author and may not necessarily state or reflect those of ANZ.